I am the founder and CEO of CircleUp, an accredited investor crowdfunding platform focused on consumer and retail companies. Before I started CircleUp, I worked in consumer-focused private equity at TSG Consumer Partners and Encore Consumer Capital. My experience in private equity exposed me to many great consumer and retail businesses that were too small to obtain funding through the traditional private equity channels. I created CircleUp to open up these investment opportunities to more investors, helping the best of these businesses gain access to capital while lowering the cost of investment for individual and small institutional investors. I received my MBA from Stanford and BA from Duke. I also hold Series 24, 63, and 82 licenses. You can connect with me through http://www.facebook.com/CircleUp.

Why VC Investors Have Historically Overlooked Consumer Packaged Goods

Someone asked me recently why CircleUp focuses on equity crowdfunding for consumer packaged goods. Given that CES is fueling the usual tech hype in Vegas as I write this, I thought I might explain why CircleUp is dedicated to the seemingly contrarian strategy of equity investing in the consumer and retail industries.

To begin with, we see the potential from global secular trends in CPG in the next decade and beyond. By 2025, for the first time ever, the number of people globally with discretionary income will exceed the number struggling to meet basic needs–“a phenomenon,” McKinsey & Co. says, “that may well be the biggest opportunity in the history of capitalism.” Want to know why we love consumer and retail? Read this post.

The manufacturing plant in the second half of the 19th century (Photo credit: Wikipedia)

CircleUp sees an opportunity to help investors channel equity investments to consumer packaged goods startups that are overlooked due to venture capitalists’ fascination with technology startups. The magnitude of the VC world’s tech mania is amazing. In the third quarter of 2013, for example, the software industry received almost half of all VC funding. Venture capitalists invested $7.8 billion in 1,005 deals in the third quarter, according to the MoneyTree™ Report from PricewaterhouseCoopers LLP and the National Venture Capital Association. The software industry received the highest level of funding, with $3.6 billion flowing into the sector during the quarter. Software also counted the most deals in the third quarter at 420, and nine of the 11 largest investments in the quarter went into software companies.

This outsized enthusiasm for tech – which has not always brought outsized returns — creates inefficiencies in angel and VC investing. CircleUp is addressing those inefficiencies.

The reasons that VCs have not paid a lot of attention to CPG are both structural and financial.

Structurally, VCs have tended to overlook CPG due to the ecosystem that has evolved around tech innovation. Since their rise 50 years ago in Silicon Valley, professionally managed venture capital firms have poured money into technology businesses.

Tech investors dominate Forbes’ annual Midas List of the most successful venture capitalists. Not only have they risen to the top by investing in technology, most graduated from universities with strong engineering and science programs – Harvard, MIT, Dartmouth and, of course, Stanford. What we see is Peter Lynch’s maxim “invest in what you know” in action among venture capital investors.

Nowhere is the nexus between schools, investors and tech startups more clear than in the Bay Area. Stanford and Cal churn out talented, ambitious engineers and science majors at a phenomenal rate to feed Silicon Valley. At Cal, 13 percent of undergraduate degrees are in engineering and computer sciences. At Stanford, an astounding 25 percent of undergraduates and more than half of graduate students are engineering majors. There are more than 2,200 members of the LinkedIn group for Stanford student and alumni entrepreneurs, Stanford Startups.

The network of science and engineering graduates, entrepreneurs and angel and VC investors is strong and heavily geared toward technology, whether you are in the Bay Area, New York, Denver-Boulder, Boston or Austin.

Rather than pound the pavement for capital, tech startups are able to raise money quickly from a relatively efficient market of angels and VC firms that are hungry to invest in tech. No, I’m not saying the private markets in tech are perfectly efficient, or even as efficient as large cap public markets. But I am saying that there is certainly much more funding in tech than any other sector. After they raise money, there is a collection of resources, including other talent, incubators and strategic advisors that provide access to professional networks and potential board members to help them build the business.

That same network is there to help them bounce back from failure. Ironically, there may be no place or industry on earth that rewards failure as much as Silicon Valley. A study of 22,000 VC-backed companies from 1987 to 2008 by the Kauffman Foundation found that 15 percent were liquidated and 19 percent expected no return to investors. Trying again and again earns entrepreneurs bragging rights. Next to “millionaire,” the most coveted title in the tech sector may be “serial entrepreneur.” Frequently, raising money is celebrated as the accomplishment (see: most tech blogs). That mentality has helped to create a culture in the Bay Area that drives people to start companies. Those companies, often in the tech sector, have changed the world for the better. But there are also a lot of failures.

Consider Color Labs. Despite a questionable product strategy, Color was able in 2011 to raise $41M from VCs., What was it? Some sort of mobile, local, photo sharing app. Based in Palo Alto, Color imploded at the end of 2012.

The high rate of failure, and the large amounts that VCs typically put into tech companies, mean VC firms need big wins to offset the clunkers. If you’ve raised money from a VC firm before, you know the question you’ll get asked is “how does this become a billion dollar business.” The Kauffman Foundation study found that just 9 percent of VC-backed companies went public. Their winners have to be huge winners. So VCs are set up to be homerun hitters. Every VC firm in Silicon Valley has a mantra: Invest in billion-dollar businesses. But those are rare creatures.

As Cowboy Ventures founder Aileen Lee points out, an analysis of VC investing since 2003 “found 39 companies belong to what we call the ‘Unicorn Club’ (by our definition, U.S.-based software companies started since 2003 and valued at over $1 billion by public or private market investors). That’s about .07 percent of venture-backed consumer and enterprise software startups.” So while it’s sexy for VC firms to say “we only invest into billion dollar companies”, the reality is they are wrong 99.93% of the time.

VC funds need both high internal rates of return (IRR), and big dollar returns. I had a well-known VC firm say to me, “We know a personal care company we love. Its $5 million in revenue, and everyone here believes it goes to $80 million in revenue. But that [dollar gain] isn’t big enough for us to include in our portfolio.” When you’re losing big checks at such a high rate, as VC firms tend to do, you need the winners to be big winners.

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